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Monthly Archives: May 2016

The many problems with the Investment Advisers Modernization Act

While Americans for Financial Reform and our allies are busy campaigning for closing loopholes that are special privileges for private funds, the Majority on the Hill is proposing to do away with even the limited existing reporting requirements to protect investors and increase accountability.

On May 17th, the House Financial Services Subcommittee on Capital Markets held a hearing to discuss a bill called the Investment Advisers Modernization Act of 2016. Far from actually modernizing the industry, the bill rolls the clock back to a time when private fund advisers operated in the shadows, without meaningful oversight. The bill would enable the exploitation of investors and reduce the information available to regulators to address systemic risk by rolling back key reporting requirements, and by interfering with the Securities and Exchange Commission’s ability to investigate fraud at individual firms. (For a full breakdown of the problems with this bill, please see AFR’s opposition letter).

One of the witnesses who testified was Jennifer Taub, a Professor at Vermont Law School and author of Other People’s Houses, a book on the foreclosure crisis. Professor Taub pointed out in her written testimony that the Investment Advisers Modernization Act could not only “undermine investor protection and trust, which could inhibit or drive up the cost of capital,” but would also “allow certain private equity advisers and other private fund advisers that have been exposed as lacking in recent SEC examinations to hide their tracks.”

Last week, some members of the House Financial Services Committee lavished praise on a piece of legislation they said would “restore due process rights to all Americans.”

“All the bill says is that if somebody wants their day in court, they should have their day in court,” the bill’s sponsor, Rep. Scott Garrett (R-N.J.), explained, adding that “preserving the rights of Americans to defend themselves in a fair and impartial trial…is one of the most fundamental rights, and it is enshrined in our Constitution.”

Representative Jeb Hensarling (R-Texas), Chair of the committee, championed the measure as well. “Every American deserves to be treated with due process,” Rep. Hensarling declared. “They ought to have the opportunity to have a trial by jury. They ought to be able to engage in full discovery. They ought to be subject to the rules of evidence.”

A listener might have thought these legislators were standing up againstforced arbitration — “rip-off clauses” that big companies bury in the fine print of contracts to prevent people from suing them, even if they have broken the law.

Astoundingly and unfortunately, the legislators were actually moving in the opposite direction. They were extolling HR 3798, the so-called “Due Process Restoration Act,” which would extend special legal protections to Wall Street banks and other financial firms charged with violating federal securities law by the Securities and Exchange Commission (SEC).

This piece of legislation does nothing to restore due process to ripped-off consumers and investors. Instead, the “Due Process Restoration Act” makes it harder for the SEC to hold corporate wrongdoers accountable when they break the law.

Big banks and others charged in SEC hearings already possess several crucial legal protections that their investors and consumers lack in forced arbitration: robust opportunity for discovery, a public hearing, a trained adjudicator bound to make a ruling based in law, and — crucially — the right to two full appeal processes, including a review in federal court. Yet HR 3798 would make it harder for the SEC to prove its case and allow the accused party to unilaterally terminate the proceedings, forcing the SEC to either drop the charges or refile in federal court.

According to Professor Joseph Carcello of the University of Tennessee, giving companies this right to “choose the venue is unlikely to be in the best interest of society, and will almost certainly make it more difficult for the SEC to deter and punish securities law violations, including fraud.” Professor Carcello further emphasized that if fairness is a concern for members of the committee, then it is more unfair for citizens to be forced into arbitration in their contracts with financial institutions.

An amendment offered by Reps. Keith Ellison (D-Minn.) and Stephen Lynch (D-Mass.) threw the gap between the words and actions of HR 3798’s supporters into particularly stark relief. The amendment would have ensured that firms using forced arbitration against consumers and investors could not benefit from the bill’s special protections. Yet, in a display of staggering hypocrisy, this commonsense amendment was defeated on party lines.

Despite grandiose claims of due process, HR 3798 would only further tilt the playing field in favor of special corporate interests when it comes to battling financial fraud and corporate rip-offs. If lawmakers truly wish to “restore due process rights to all Americans,” they should pass legislation to ban forced arbitration and support the upcoming Consumer Financial Protection Bureau rulemaking on this abusive practice.

Wall Street firms and brokers accused of breaking federal law do not need special legal protections, but the right of ordinary Americans to have their day in court very much does need defending. Lawmakers should legislate accordingly.

Recently, a former SEC trial attorney has placed a bright spotlight on the failure of his old agency to charge more individuals at Goldman Sachs over securities fraud in the “Abacus” deal. Abacus was composed of mortgage securities that Goldman knew were toxic. But they packaged them up and sold to investors anyway, and then actively bet against those investors. It is a stark example of a serious conflict of interest.

Unfortunately, not only have the bankers responsible for the conflicted deals gone unpunished, but also the Dodd-Frank rule targeted at stopping material conflicts of interest remains unfinished. (For more on why the rule is important, see AFR’s 2012 letter).

Last week, Senators Feinstein, Merkley, Markey, Boxer, Franken, Durbin, Warren and Reed sent a letter to the SEC urging them to prioritize completion of this long-neglected rule. The letter highlights that the SEC is over 1,730 days late on completing this rule:

“The SEC was directed to issue rules no later than 270 days after the enactment of Dodd-Frank. It has now been over 2,000 days since the President signed Dodd-Frank into law. This is unacceptable. We urge you to work quickly to finalize strong rules implementing Section 621.”

The letter also highlights the problem with leaving Dodd-Frank’s conflict of interest rule unfinished:

“As you know, Section 621 prohibits material conflicts of interest for those involved in structuring asset-backed securities and serves as a critical component of financial reform based on the lessons we learned from the financial crisis. The U.S. Senate Permanent Subcommittee on Investigations’ April 2011 report on the financial crisis detailed some of the transactions that were designed to fail so that the entities constructing them could bet against them and profit. This is an appalling practice that the SEC can address by releasing a strong final rule on Section 621.

Financial institutions should not be able to sell securities to investors and then bet against those same securities, to purposefully design securities or structures with the intent that they will fail or with defective components, or to mislead investors by structuring products specifically intended to benefit an undisclosed entity. These types of structures are built on deception, and withholding material information is fundamentally contrary to the efficient operation of our financial markets and to the protection of investors.”

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This blog is maintained by AFR as a forum for ongoing news and commentary about the fight for effective financial reform. Blog posts represent the opinions of their authors / posters, and do not necessarily represent the views of the AFR coalition or coalition members.